This is a blog about interacting systems and how they behave: systems thinking construed broadly. Financial markets and economics; politics; and occasionally physical systems are discussed, with an attempt at focusing on how the rules of the game determine the strategies of participants and the possible outcomes.

Wednesday, 3 December 2008

Meredith turns Japanese

A more or less parenthetical remark by Meredith Whitney (quoted in the FT) resonated with me. The note from Oppenheimer included a number of recommendations: here is the third:

Delay the introduction of accounting rule FAS 140 until 2011 or 2012. These moves to bring off-balance-sheet assets back on balance sheet for the sake of transparency are a mirage. The primary assets that will come back on to balance sheets are credit card loans. Frankly, there is more transparency in off-balance-sheet master trust data than in on-balance-sheet accrual accounting.

What struck me was how true this is. The buyers of credit card backed securities won't put up with accrual: they know it hides all sorts of issues they need to see and is usually used to smooth earnings. So why should we put up with it for on balance sheet assets?

This in turn brought to mind a section from a nice short summary on the Japanese crisis I have been reading. From The Japanese banking crisis in the 1990s by Kazuo Ueda:

Large Japanese banks had capital ratios of barely above 8% at the start of the 1990s, with about half of the 8% accounted for by unrealised capital gains on their equity positions. Since then, banks have beenwriting off bad loans by basically using operating profits and realising latent gains on equity positions.

Unrecognised losses in accrual accounted loans only being taken when enough earnings materialise to absorb them. Does that sound familiar? You can't fix the problem until you can see the problem. At least a diligent attempt at establishing fair value helps you to see the problem.